Does the dividend payout affect NAV?

[trustee]

I know the capital gains reduce the NAV of an index fund but do dividends do the same? Thanks!

 

[haha]

Yes.

 

[trustee]

It looks like I mistakenly purchased Vanguard Total bond fund in a taxable account. Would I be better off converting this to a tax exempt fund like the long term muni before the distribution ?

 

[haha]

Your first question was generic. This second one requires an understanding of your situation, so I would not be qualified to give an opinion. Generically, it is better to keep things that will pay non tax-favored distributions out of your taxable account, unless you are looking for some taxable income, for example to avoid Medicaid or some other reason.

Ha

 

[trustee]

Sure. Here is a breakdown.

Age: 28
Tax Filing Status: Single
Tax Bracket: 28%

Debt: 98k on Mortgage @ 4% fixed, 11k on student loan @ 6.5% variable
I have roughly 110k in equity on the home and I will be selling it in 2014.

Total Portfolio Size: 72k

401k: 32k
Vanguard Total Retirement 2030

Roth IRA 5.5k
Vanguard Total Retirement 2060

Taxable Brokerage Account: 35k
Vanguard Total Stock Market Admiral 21k
Vanguard Total International Admiral 11k
Vanguard Total Bond Market Investor 3k

Any ideas on adjustments I should make?

For 2014, I will be maxing out 401k, Roth IRA, and contributing the rest into ibonds.

 

[haha]

Sure. Here is a breakdown.

Age: 28
Tax Filing Status: Single
Tax Bracket: 28%

Debt: 98k on Mortgage @ 4% fixed, 11k on student loan @ 6.5% variable
I have roughly 110k in equity on the home and I will be selling it in 2014.

Total Portfolio Size: 72k

401k: 32k
Vanguard Total Retirement 2030

Roth IRA 5.5k
Vanguard Total Retirement 2060

Taxable Brokerage Account: 35k
Vanguard Total Stock Market Admiral 21k
Vanguard Total International Admiral 11k
Vanguard Total Bond Market Investor 3k

Any ideas on adjustments I should make?

For 2014, I will be maxing out 401k, Roth IRA, and contributing the rest into ibonds.

No, I am sorry. I didn't mean to imply that I feel I can analyze and advise. Someone will be along shortly for sure.

Ha

 

[karluk]

I know the capital gains reduce the NAV of an index fund but do dividends do the same? Thanks!

Ha's post stating that dividends affect NAV is incorrect. He was unaware that you were referring to a Vanguard bond fund. Unlike stock funds, bond funds accrue interest daily, even though the dividend is paid monthly. Since the dividend consists of accrued interest, the distribution doesn't affect NAV at all.

You should sell the bond fund as soon as possible, so as to avoid receiving a lot of taxable dividends, but it's not essential to sell before the dividend date. Regardless of when you sell, you will receive a check for both the amount of the shares you purchase and the amount of the accrued interest.

Here is an excerpt from the Boglehead's article on NAV, which lucidly describes the difference between stock and bond dividends:

Bond funds versus equity funds

Most Vanguard bond funds accrue interest to the share holders daily. Here is a typical statement from a prospectus:

Each Fund distributes to shareholders virtually all of its net income (interest less expenses) as well as any net capital gains realized from the sale of its holdings. The Fund’s income dividends accrue daily and are distributed monthly.

The term accrue used in this sense means that the income dividends are credited to your account each day, just like interest in a savings account that accrues daily. Since the money set aside for your dividends is both an asset of the fund and a liability, it does not affect the calculated net asset value. When the fund distributes the income dividends at the end of the month, the net asset value does not change as both the assets and liabilities decrease by exactly the same amount. [Note that if you sell all of your bond fund shares in the middle of the month, you will receive as proceeds the value of your shares (calculated as number of shares times net asset value) plus a separate distribution of the accrued income dividends.]
In most equity funds and balanced funds, dividends do not accrue to you; and you only become entitled to them if you hold the fund on the distribution date. Therefore, accumulated dividends are not liabilities of the fund; as dividends come into the fund, the net asset value increases. Only when the dividends are paid out does the net asset value decrease by the dividend amount.

Net asset value - Bogleheads

 

[haha]

Ha's post stating that dividends affect NAV is incorrect. He was unaware that you were referring to a Vanguard bond fund. Unlike stock funds, bond funds accrue interest daily, even though the dividend is paid monthly. Since the dividend consists of accrued interest, the distribution doesn't affect NAV at all.

Well, I am glad you happened along karluk. I have several (non-Vanguard )bond funds that also accrue interest daily, as it is received, but drop substantially in NAV on xd date which on these particular funds is also pay date. The drop attempts to match penny for penny the amount paid out.

In my funds, if bond prices are stable, when I see my dividend reinvestment reflected in additional shares, the value of the total shares times the new share price, will more or less equal the value of the old shares at the higher, pre-distribution price. Can this be explained by we somehow using words in different ways? When I read the part you quoted above, I still don't quite get what is being talked about. My bond funds seem to be using cash accounting within the fund, just adding cash received to the asset value. Underlying bond interest payments are accrued to the fund holder, by the mechanism of the bond fund NAV increasing as interest payments are received from the underlying bond holdings. But if I sell mid-month, to the best of my understanding which I have to check to be sure, what I get is my share of cash that has been paid to the fund by the bonds since the last dividend paid by the fund, plus the NAV of the bonds themselves. Some of the bonds in these funds probably trade flat.

From your paragraph, it seems that Vanguard does it quite differently, so I will have to ponder this a while so I can can fully understand.

It is very interesting!

Ha

 

[trustee]

Thanks for the feedback karluk. Any recommendations for a bond fund to have in a taxable account?

 

[Animorph]

For a 10% allocation of bonds in your taxable account, I wouldn't worry about it too much. For qualified dividends taxed at 15% I wouldn't worry about it too much.

Anything that throws off distributions of any type would generally be better in a tax advantaged account. However, bonds also have lower expected growth, so I think there is some tradeoff in placing them there.

 

[karluk]

Thanks for the feedback karluk. Any recommendations for a bond fund to have in a taxable account?

Giving a recommendation is too much like offering investment advice, which I try to avoid. If you want to stay with Vanguard, I see that they list 12 different tax exempt bond funds, as well as a bunch of taxable funds, in the following link. You could pick the one that offers the best after-tax yield for the risk that you're willing to take.

https://investor.vanguard.com/mutual-funds/vanguard-mutual-funds-list?assetclass=bond